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When income stocks start offering dividend yields in double-digit territory, that’s when investors should become sceptical. While these enormous payouts can seem like golden opportunities at first, they’re often followed by a cut due to their unsustainability.
However, there are always exceptions to this rule. And by successfully identifying businesses that most investors are underestimating, some enormous passive income streams can be unlocked. That’s what’s brought Foresight Environmental Infrastructure (LSE:FGEN) onto my radar.
With a share price of around 68.3p, a single £500 lump sum is enough to buy approximately 732 shares today. And with a yield of 11.5% on offer, the renewable energy trust currently offers the biggest payout in the entire FTSE 350.
So, is this a trap or a hidden opportunity?
The bear case
Let’s start with why investors don’t seem to be very optimistic that Foresight’s current dividend can be maintained.
Beyond the general weak sentiment surrounding renewable energy companies right now, there are valid reasons to be concerned about dividend sustainability. For example, Foresight’s balance sheet does carry a significant chunk of debt, putting pressure on the group’s cash flow.
This pressure is slowly being alleviated through refinancing efforts alongside gradual interest rate cuts from central banks across the UK and Europe. Yet rate cuts are proving slower than initially expected. And with the bubbling political environment across Europe, renewable energy policies could be at risk of disruption in the coming years.
For Foresight, that could prove disastrous since a large portion of its revenue is tied to government subsidies. And when combining these political, macroeconomic, and financial risks, it’s not surprising that investors are reluctant to add this income stock to their portfolios.
The bull case
While the risks and threats are substantial, these come paired with some pretty significant positives that may be ignored right now.
Foresight’s project portfolio is fairly broad, preventing any single-asset concentration risk while also exposing the business to multiple niches within the renewable infrastructure space. At the same time, the structure of most of its contracts includes inflation-linking, protecting the business and — in turn –shareholders from rising costs.
As such, even with a long history of having a high dividend yield, shareholder payouts have continued to grow each and every year for the last decade. And looking at its latest results, the group’s cash flows continue to cover dividends by around 1.3 times. That’s still tight but not disastrous and suggests that a payout cut is not imminent.
The bottom line
Despite being in the double-digits, Foresight’s dividend yield currently looks sustainable. Providing that energy prices don’t suddenly plummet or subsidies are cut, the group’s coverage ratio could expand further, securing dividends and potentially attracting investors back into this space.
Political pressure from UK and European parties seeking to redistribute funds towards nuclear projects is a problematic medium-term threat. But cuts to subsidies are far from guaranteed. And a good chunk of this risk seems to already be baked into the weakened share price.
That’s why I think this income stock is worth a closer look for investors who don’t mind taking on a bit of risk.
